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Ambitious mitigation of greenhouse gas emissions to keep global warming well below 2°C, as agreed in the Paris Agreement, requires national climate policies that trigger unprecedented redirection of investments. It is the primary function of the financial system to facilitate these investment efficiently, but research and experience from financial crises reveal severe limits to the functions of the capital markets. This research proposal combines climate change economics and financial economics to study the role of capital markets and investor behavior for climate policy. To this end, we propose to integrate key elements of the financial sector like banks and large investors into climate policy models to analyse constraints on capital and finance and assess their impact on the effectiveness and the cost of climate policy. From understanding these imperfections of capital markets, we intend to infer optimal policy responses in form of adjusted climate policy and complementary financial policy. In this context, the role of large institutional investors that concentrate vast funds will be a special focus of the project to analyse how their long time horizon and, in case of sovereign wealth funds, fossil resource wealth motivate them to support or counteract climate policy. Findings will advance the understanding of finance as a key part of the economic system, draw attention to potential complications for climate policy, and provide options for policy makers to facilitate finance for climate policy.

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